8 The Management of Bond Investments and Trading of Debt
1.3 Creativity, innovation, and tax incentives
In the virtual economy, which is based on debt rather than real assets, creativity is the
best source of growth and of creation of wealth. Therefore, the value of education
rises exponentially, particularly when it focuses on conceptual solutions and analyti-
cal thinking, or both. Creativity and innovation are the tools needed to address in an
able manner the:
Design of new financial products for the virtual economy
Optimization of factors which increase the instruments’ appeal to the market,
Management of exposure, which becomes more polyvalent because of new ways
of assuming risk (see Chapters 12 and 14).
The message these three bullets carry may seem to be quite apart from, or even
irrelevant to, the democratization of credit. In reality, it underpins this process
because credit and lending are no more limited to the working man in search of a
personal loan, as was the case with the first personal loans offered by City Bank in
1928. In its most recent incarnation, the democratization of credit is leverage – and
from there a way of gaining market edge.
People or companies find benefits in being ahead of the curve. In their search for
market edge, 21st century companies must not only review their cost structure and
trim it down, but also steadily look for new higher margin instruments and markets,
as well as novel types of risks and their control. With the boom in debit instruments
risk management has become the cornerstone of value differentiation (see Chapter
15) all the way to capital allocation, including identification of concentrations of risk
across a company’s assets and liabilities structure.
To a very significant extent, training people for creativity and innovation is an issue
novel to the educational establishment. Putting it in action requires massive changes
in the curricula of schools and universities, steady faculty retraining, and refocused
student objectives. Another prerequisite is efficient administration of a program
aimed at providing new solutions to an economic environment characterized by the
democratization of credit and socialization of risk.
Tax optimization provides an example (see also Chapter 5). One of the reasons,
but only one, why companies and individuals favor debt over equity is that the
laws making up the tax system have a pronounced positive bias for debt. Debt pay-
ments are tax-deductible and this has been enough of an incentive to provide a
good part of the oiling of the economy through skyrocketing debt. The tax system
favors debt financing over equity capital; which means bonds over stocks. If paid
out in the form of a dividend to the stockholder, a dollar of corporate earnings is
taxed twice:
First at the corporate tax rate, which is a high 50–60% depending on the country
Then at the individual tax rate, which can be as high as 90%, also depending on
the jurisdiction.

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